citizens for public accountability houston's $1.7 billion operating losses

8/8/2019 Citizens for Public Accountability Houston's $1.7 Billion Operating Losses

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JULY 2010 BY: BOB LEMER GRAPHICS: PIPER WILLIAMSON

CITY OF HOUSTON

TOTAL

OPERATING LOSSESFISCAL YEARS 2004-2009

$$11..77BBIILLLLIIOONN



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The City of Houston Is Teetering On The Edge Of A Fiscal AbyssBy: Bob Lemer

Executive Summary

The City of Houston is teetering on the edge of a fiscal abyss, as proven by: (a) the audited financial statements and other dataincluded in the City’s latest (2009) Comprehensive Annual Financial Report (CAFR); and (b) the fiscal year 2010 “actual” dataand the fiscal year 2011 “budgeted” data, both included in the City’s official budget for fiscal year 2011.

In my opinion, the City’s only hope for sol ving this fiscal crisis is for the business sector to immediately and assertively becomeinvolved in the situation and help guide the City out of its frightening fiscal crisis. The business sector has a vital need to do thisbecause a collapse of the City ’s finances would seriously harm the economy for the entire Houston metropolitan area.

The severity of the fiscal crisis is evidenced by the City’s deficit of $1.7 billion in unrestricted assets at June30, 2009 , the as of date for its latest publicly ava ilable audited financial statements. In other words, the City‟s unrestricted assets at June30, 2009 totaled $1.7 billion less than the already recorded liabilities the unrestricted assets would have to cover.

The crisis is further evidenced by the fact that the City’s currently positive general fund balance exists solelybecause the general fund balance has been wholly financed by the proceeds of long-term pension bonds . SeeExhibit G.

The $1.7 billion deficit in unrestricted assets at June 30, 2009 resulted from operating losses of $1.7 billion for fiscal years 2004-2009(Exhibit A). The vast majority ($1.5 billion) of the $1.7 billion of losses occurred during fiscal years 2004-2008--before the currentserious economic recession. The $1.5 billion of operating losses occurred during fiscal years 2004-2008 even though each of those fiscalyears saw record levels of revenues from property taxes and sales taxes.

Houston‟s $1.7 billion of operating losses is incredibly worse than the operating results of the rest of Texas‟ 10 largest cities. But the $1.7billion of operating losses is really staggering when compared to the operating results of the larger cities in the essentially bankrupt Stateof California. And even the rotting city of Detroit had better operating results than Houston. See Exhibit B.

The $1.7 billion of Houston losses resulted primarily from overly generous and totally unsustainable pensionand other retirement benefits such as health care. The $1.7 billion is almost twice the total annual propertytax revenues of the City.

The sudden granting of overly generous pension benefits and the evidence that they are unsustainable over time are well illustrated bythese Exhibit C and Exhibit D facts: (a) Per Exhibit C, as of June 30, 2003, the pension plans had been paid practically all amounts(except for a net $54.4 million liability) required to be accrued by generally accepted governmental accounting principles; (b) Per ExhibitD, the City‟s contributions to the plans, as a per cent of p ayroll costs, rose dramatically during 2004-2009; and (c) Yet, per Exhibit C, theCity‟s pension liabilities still mushroomed to an astounding $1.2 billion at June 30, 2009.

The $1.7 billion deficit was financed by delaying payment, long-term, for $1.7 billion of liabilities for benefits already earned byemployees for pension and other retirement benefits, according to generally accepted accounting principles for governmental entities. SeeExhibit C. Almost $600 million of such currently earned debt was converted to long-term property-tax-supported public obligationbonds, backend loaded so that future generations would have to pay for them, plus uncalled for extra interest costs.

The $1.7 billion deficit has effectively transferred financial ownership of the City from the Houstontaxpayers to City employees (see Exhibit E).

As shown by Exhibit E, in reality, the City’s deficit in unrestricted assets is more like $8.5 billion, ratherthan $1.7 billion, due to many more not funded and not recorded retirement- related liabilities to the City’semployees . The $8.5 billion is a mind-blowing more than 9 times the total annual property tax revenues of the City.

Apparently the real elephant in the room now is the tremendous health care benefits for retired Cityemployees . Exhibit C reveals that the City recorded liabilities of $485.8 million as of June 30, 2009 for earned retirement benefitsother than pensions, primarily for health care.



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Very troubling, the City’s 2009 CAFR shows that the City’s un -funded actuarial liability for health carebenefits was $3.1 billion at June 30, 2008, the last actuarially determined date. That is a much greateramount than the City’s un -funded actuarial liability of $1.9 billion for pension costs, as of the same date,June 30, 2008. That is very scary indeed . See Exhibit E.

The City‟s slide toward fiscal disaster (on the full accrual basis of accounting) has been masked by diverting attention to t he (modifiedaccrual basis of accounting---essentially cash basis) Genera l Fund‟s “positive” fund balance. But that is disingenuous, for theGeneral Fund’s fund balance has been “positive” since fiscal 2005 only because the City has used pensionbond proceeds to cover a significant portion of annual pension funding requirements . See Exhibit G.

To the City‟s credit, its fiscal year 2011 budget does not provide for playing the pension bond issuance shell game any longe r. However,that source of funds has been replaced by planned significant (“fire”?) sales of City assets in fis cal year 2011. That is nothing but astopgap measure.

The City is really up against a fiscal wall regarding possible additional revenues . Property taxes and sales taxesmake up about two- thirds of the City‟s budgeted revenues for the general fund for fis cal year 2011. According to page 70 of the 2009CAFR, there is a voter-approved $0.50/$100 cap on the portion of the property tax rate that can be used to cover City general fundoperating expenses. The City already is using close to that rate. And the City already is charging the maximum sales tax rate allowed bythe state constitution.

So Houston voters would have to approve any increase in the $0.50/$100 operations cap on property tax rates. And Texas voters wouldhave to approve any increase in the sales tax rate. Getting such voter approvals would be a daunting task given the hardships voters arealready experiencing in the current recession.

The California cities apparently boosted their city treasuries for the short-term by increasing revenues through dramatically raising taxrates (see Exhibit B). But to what end? Apparently that only exacerbated the flight of businesses and high wage earners from the nowessentially bankrupt state of California. The same thing might happen to Houston if tax rates are increased here. As a matter of interest,the City of Houston‟s long -term debt per capita already is much greater than the State of California‟s.

It seems obvious to me that the only answers to solving the City‟s fiscal crisis lie in severely reducing employee retirement benefits(which will apparently require changing state law) and severely reducing City expenses. It is my opinion, from observing the City‟sfinances and operations for more than a quarter-century, that there is substantial fa t in the City‟s operating costs.

My opinion is basically confirmed by the fact that the City‟s operating costs have risen at approximately twice the combined rate of increase in population and inflation over the last quarter-century, and its total debt at about four times. As previously mentioned, even in

the 2004-2008 period of record revenues from property taxes and sales taxes, the City had operating losses totaling $1.5 billion.

It is evident that the City still lacks the resolve and/or ability to rein in its operating costs, even in the face of the current severe recession.According to pages 226-227 of the 2009 CAFR, in fiscal 2009 the City increased its civilian workforce by 5.5%, even more than the 4.1%increase in its classified workforce. The City already had the second largest workforce in Harris County, governmental or private sector.

It also seems obvious to me that solving the City‟s fiscal crisis is going to require a comprehensive understanding of the City‟s CAFR, theonly document that sets forth the necessary guiding information, but which incredibly is normally not issued until at least six months afterfiscal year end. Apparently none of our elected officials have the level of understanding of the CAFR necessary to solve the fiscal crisis.That is understandable, in that the vast majority of CPAs probably don‟t understand governmental accounting and CAFRs either.

Mr. James Moncour, deputy director, mayor‟s office, and Mr. Craig Mason, chief pension executive, attended my July 22, 2010presentation to the Business Issues Committee of the Greater Houston partnership on behalf of the City. My presentation handout

included only the attached exhibits, but my verbal comments covered most of the comments in these two pages.Mr. Moncur‟s response seemed to basically center on the City‟s favorable bond ratings. I truly cannot understand how the threemunicipal bond rating agencies can continue to give the City of Houston such high bond ratings on its general obligation bonds. I believethey do so at their own peril. I suggest that the business community request that the CEOs of the three municipal bond rating agenciesrespond in writing to this document.

Mr. Mason„s response seemed to exhibit little concern over the City‟s non -payment of such a large portion of the pension liabilitiesrecorded in accordance with generally accepted governmental accounting principles. His response seemed to be that pension fundingmust be looked at over a long period of time and there is no cause for alarm at this time. I find that position impossible to reconcile withthe facts shown in this document. Particularly when the facts in this document were derived from the City‟s CAFR, budget and monthlyfinancial and operations documents.



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SUMMARY: The City is teetering on the edge of a fiscal abyss. The business community is our best andlast hope for guiding the City back to fiscal stability. But this cannot happen unless the business communityresponds now, not later. Please see Exhibit J for some suggested possible initial actions.



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Exhibit A

Annual Operating LossesFiscal years Ended June 30, 2004-2009

By Bob Lemer

City had operating losses totaling $1.7 billion for the six fiscal years endingJune 30, 2009 – per page 197 of the City‟s 2009 Comprehensive Annual FinancialReport (CAFR). These numbers agree with the City‟s audited financial statementsfor fiscal years 2004-2009. For example, see bottom of Total column on page 17 of thefiscal year 2009 CAFR. See Note below regarding terminology used.

2004 ($ 312,790,000)

2005

( 531,465,000)2006 ( 131,893,000)

2007 ( 221,452,000)

2008 ( 281,556,000)

Total before recession ($1,479,156,000)

2009 ( 214,817,000)

TOTAL ($1,693,973,000)

Approximately $1.7 BILLIONin operating losses!

The operating losses for fiscal years 2004-2008 occurred eventhough the City received record revenues from property taxesand sales taxes each year.

Note: governmental accounting terminology for excess of expenses over revenues is“Change In Net Assets” rather than “Net Loss” or “Operating Loss.” This is becausegovernmental entities are not operated for profit.



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Exhibit B

Comparison of Selected CityGovernment Operating Results

Total for Fiscal Years 2004- 2009* as Reported on Cities’ Web Sites By Bob Lemer

$1 billion

-$1 billion

$0

-$2 billion

$2 billion

$3 billion

$4 billion

Houston−$1.7 billion

Detroit−$0.8 billion

SanFrancisco

$0.5 billion

SanDiego

$1.2 billion

Los Angeles$3.7 billion

thru 6/30/2009

thru 6/30/2009

thru 6/30/2009 thru 6/30/2009 thru 6/30/2009thru 9/30/2008*

*Amount for Dallas is for only five fiscal years (2004- 2008). Dallas’ CAFR for fiscal year ended September 30, 2009 has not yet been publicly released.

Note: Of the ten largest Texas cities, only Houston and El Paso had cumulative operating losses for fiscalyears 2004-2009. Arlington, Austin, Corpus Christi, Dallas, Fort Worth, Lubbock, Plano and San Antonio allhad cumulative operating surpluses from operating results for fiscal years 2004-2009.

Dallas*$0.8 billion



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2003 2009 IncreaseAccrued liabilities to pension plans:

Police Officers $19.2 ) $369.8 $350.6

Firefighters – prepaid at June 30, 2003 (57.2) 27.2 84.4Civilians 92.4 ) 313.1 220.7Total due to pension plans $54.4 ) $710.1 $655.7

Pension bonds payable -0- ) 587.5 587.5UNPAID PENSION COSTS $54.4 ) $1,297.6 $1,243.2Unpaid recorded liabilities for health care

and other post-retirement benefits -0- ) 485.8 485.8TOTAL LIABILITIES FOR PENSIONSAND OTHER POB $54.4 ) $1,783.4 $1,729.0

Exhibit C

How the $1.7 Billion inOperating Losses Was Financed

By Bob Lemer

Houston‟s $1.7 billion in operating losses for fiscal years 2004 -2009 created a $1.7billion deficit in unrestricted assets as of June 30, 2009. See page 15 of the 2009CAFR.

In other words, the unrestricted assets were $1.7 billion less than the already recordedliabilities they would need to cover.

The $1.7 billion in operating losses for fiscal years 2004-2009, and the resulting $1.7billion deficit in unrestricted assets at June 30, 2009, were financed via the followingincreases in recorded liabilities:

(In Millions of Dollars)Balances at June 30

Per 2003 and 2009 CAFRs

EQUALS $1.7 BILLION



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0

5

10

15

20

25

30

35

2003 2004 2005 2006 2007 2008 2009

Pension Plan Year

% o f

S a l a r i e s

& W a g e s

Police Officers Firefighters Civilians

Exhibit D

City’s Contributions Actually Made toPension Plans, as a Percentage of

Salaries and Wages Paid Fiscal Years 2003-2009

By Bob Lemer

15.4%16.4%

18.0%

24.8% 23.7% 23.9%

29.4%

10.0%

14.7% 16.9%

16.5% 16.0%

15.7% 14.8%12.4%

12.4%11.3%

15.9% 15.5%

16.3%

18.7%

Firefighters Police Officers Civilians

Thus, even though the City‟s unpaid pension liabilities dram atically increased from fiscal year 2003 to fiscalyear 2009 (see Exhibit C), the City‟s actual contributions to the plans significantly increased during thatperiod (as a per cent of salaries and wages paid). Percentages shown were derived from the applic able year‟sCAFR. For example, for fiscal year 2009 percentages, see page 94 of the 2009 CAFR



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−$8.5billion?

$14 billion

$12 billion

$10 billion

$8 billion

$6 billion

$4 billion

$2 billion

−$2 billion

−$4 billion

$0

−$0.3billion −$1.3

billion

−$3.3billion

−$6.5billion

$5.0billion

$8.6billion

$10.6billion

$13.8billion

−$6 billion

−$8 billion

−$10 billion

June 30, 2003CAFR

June 30, 2008CAFR

June 30,2009 CAFR

Note A Adjustment

Note B Adjustment

Exhibit E

Transfer of Wealth from Houston Taxpayers to City Employees(The Majority Of City Employees Do Not Live In The City)

By Bob Lemer

City Employees’ Net Assets

Surplus

Houston Taxpayers’ Net Asse

Deficit

Note A - Balance after adjusting for $1.9 billion oCity’s unfunded pensionliabilities to City employee(2009 CAFR page 121)

Note B - Balance after furthadjusting for $3.1 billion oCity’s unfunded health andother post-retirement beneliabilities to City employee(2009 CAFR page 122)

Note C - The City’s deficit be even greater when it has

reimburse the City employpension plans for theinvestment losses(approximately $1.8 billionincurred by the plans in fisyear 2009. The City’s actucomputations for fiscal yea2009 were based upon theactuarial report as of June 2008, before the pensionplans’ market losses infiscalyear 2009.

Note C Adjustment

$13.6billion

$11.8billion

$8.7billion

$6.8billion

−$1.7billion −$3.6

billion

−$6.7billion

−$8.5billion

−$1.3billion

The City of Houston‟s deficiency in unrestricted net assets increa sed from -$0.3 billion at June 30, 2003 to -$1.7 billion atJune 30, 2009, while the net assets of the City employees‟ pension plans increased 72% from $5.0 billion at June 30, 2003 to$8.6 billion at June 30, 2008, and then dropped about 20% to $6.8 billi on at June 30, 2009, according to the City‟s 2003, 2008and 2009 CAFRs. Certainly much of the increase in the value of the employees‟ pension plans was due to employeecontributions and performance of the pension plans‟ investments, but a large amount of t he of the increase of the pension

plans‟ net assets, as well as most of the decrease in the City‟s net unrestricted assets, was due to ballooning costs of City employee pension and health benefits.



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Exhibit G

Appearances vs. Actualityor

Budget and Monthly Financial Reporting vs. CAFR By Bob Lemer

−$1.75

−$1.50

−$1.25

−$1.0

−$0.75

−$0.50

$0.25

$0.50

$0.75

$0

−$0.25 ?? ??

?? ??

2003 2004 2005 2006 2007 2008 2009 2010 2011

Billions

Unrestricted (Deficit) of Governmental

Activities, per CAFR for that year.Unrestricted Fund Balance of GeneralFund. For fiscal years 2003-09, per page194 of 2009 CAFR. For fiscal years 2010-11, per 2011 preliminary budget.

Governmental Activities portion oyear end balance of pension bondspayable, per CAFR for that year.

— At June 30th —

Observations:A. The General Fund shows a positive unrestricted balance (blue) each year, for budget and monthly

financial reporting purposes--- under the “modified accrual” basis of accounting (essentially c ash basis).Yet the annual CAFR shows a (red) deficit in the unrestricted “Governmental Activities” (GeneralFund) fund balance---using the full accrual basis of accounting.

B. For fiscal years 2005-2009, a positive Unrestricted Fund Balance in the General Fund (blue) apparentlyexists due to the City having used pension bond proceeds to cover General Fund pension costs.



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Exhibit H

Can the perpetual annual operating losses be overcome by increasing assessed

revenue rates or creating new sources of revenues, without voter approval? By Bob Lemer

GOVERNMENTAL ACTIVITIES (Core mission of the City, primarily the General Fund): Property tax revenues (42.4% of General Fund revenues budgeted for fiscal year 2011):

According to page 70 of the fiscal 2009 CAFR, the maximum operations portion of the propertytax rate is $0.50/$100, per the City Charter. According to the preliminary fiscal year 2011 budget,the property tax rate for fiscal year 2011 will be close to the $0.50/$100 City Charter limit yet

total property tax revenues will decrease in fiscal year 2011, due to falling property values. Sales tax revenues (23.2% of General Fund revenues budgeted for fiscal year 2011): The City‟s 1% sales tax rate is set by the state constitution. Sales tax revenue reached its historicpeak in fiscal year 2009, and then dipped significantly in the just completed fiscal year endedJune 30, 2010. Sales tax revenue is budgeted to increase slightly in fiscal year 2011, but not to thelevel of its peak in fiscal year 2009.

Renew Houston: I have not yet analyzed the Renew Houston proposed amendment to the City Charter. Initially, itappears to me that a portion of this tax dupli cates the portion of the City‟s water and sewer ratesthat already are allocated for coverage of drainage costs by the Combined Utility System (CUS).See CUS comments below.

BUSINESS-TYPE ACTIVITIES (Activities not within the City‟s core mission, and whic h the City optedto get into):

Combined Utility System (CUS): The CUS covers the City‟s water and sewer operations as well as drainage costs. Drainage costswere moved from the General Fund (and voter control over drainage bond issuance therebystopped) to the CUS just a few years ago. Now a portion of the Renew Houston proposedrevenues appears to duplicate the portion of water and sewer rates already designed to coverdrainage costs. City council recently approved massive increases in water and sewer rates(apparently the equivalency of a 30% hike), without voter approval. Even though the revenuesthereby derived are supposedly limited to retention in the CUS, state law apparently overrides the

City Charter and City ordinances and permits the transfer of such revenues to the General Fund. Airport Fund: Airport Fund revenues consist mostly of rentals, with landing fees in significant second place.Revenues are required by federal law to remain in the Airport Fund. However, the City hasoccasionally managed to transfer some General Fund costs to the Airport Fund, therebyaccomplishing the same objective as transferring revenues.

Convention and Entertainment Facilities (CEF): The CEF revenues are principally the hotel occupancy tax, which is restricted to the CEF. TheCEF is relatively insignificant in size and has no surplus revenues to support any other Fund.



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Exhibit I

Is it wise to return to the City’s 1980s approach to increasing revenues?

By Bob Lemer

The City‟s response to the downturn in the City‟s e conomy (along with certain legallymandated water and sewer improvements) in the oil-bust 1980s was to implement thefollowing rate increases:

Property tax rate 27% Water rates 119% Sewer rates 161%

Our elected City officials need to think long and hard before repeating that approachin the face of:

The $1.5 billion operating losses incurred for fiscal years 2004-2008 (before therecession), when the City received record revenues from property taxes andsales taxes.

The continuing current recession.

Bear in mind:

The City already has increased water and sewer rates approximately 30%,without voter approval.

Houstonians will vote next November on a drainage tax proposed by aRenew Houston City Charter amendment.



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Exhibit J

Need for the Business Sector to Becomea Significant Voice in the Dialogue

Needed for Solving the Financial Crisis By Bob Lemer

Inasmuch as the elected City officials apparently lack the level of understanding of the ComprehensiveAnnual Financial Report needed to solve the C ity‟s financial crisis, the private business sector needs toimmediately become a significant voice in the dialogue needed for solving the financial crisis. I believe thatthe situation is so critical that it calls for a public oversight board.

Some of the things the City and the public oversight board may wish to consider are:

Immediately investigate this situation to make sure that it does not have the potential to be abankruptcy/pension plan crisis similar to the one experienced by the City of San Diego a few yearsago. There do appear to be some similarities.

Immediately freeze operating expenses in all departments, as well as all construction contractsnot yet started.

Have a qualified totally independent expert evaluate the City‟s financial expo sures regardingfinancial derivatives.

Go to the state legislature and get the employee pension plans converted from defined benefit todefined contribution plans.

Correct the weaknesses in the financial accounting and reporting system, as well as any otherimpediments to timely financial reporting.

Commence the practice of preparing timely and accurate quarterly financial reports using theaccrual basis of accounting.

Hire highly qualified consultants to conduct efficiency and effectiveness audits of every department,commencing with the largest first, with no sacred cows. There are unreleased reports on the policeand fire departments that can be used as beginning reference points for those departments. Considerusing a productivity and quality control consultant to make sure that customer service is adequatelyconsidered in the deliberations.

Conduct an in- depth inventory of the City‟s infrastructure and prioritize the discovered needs.

Have a qualified independent consultant evaluate the City employee benefit package.

Immediately commence ongoing CAFR workshops for all elected City officials.

Once the national financial crisis and the City‟s preceding self -created financial crisis are over, a permanentoversight City audit committee should be inst alled, as recommended by the City‟s independent auditors intheir December 17, 2002 letter to the City, and as recommended for all state and local governments by theGovernment Finance Officers Association.

citizens for public accountability houston's $1.7 billion operating losses

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